UK budget seeks to reassure city

If there was one message the British government wanted the global financial markets to hear on Wednesday as it presented its annual budget, it was this: Don't Panic. Britain is not going to abandon its program to cut the deficit and balance the books by 2016/17. But it's a strategy that opposition politicians say risks stifling growth by cutting spending too far and too fast.

The budget conveyed a controversial domestic message too - a tax cut for Britain's highest earners. By cutting the 50 percent top rate of income tax to 45 percent from April 1 next year, Britain's Finance Minister George Osborne wanted to signal that Britain is open for business, and keen to keep and attract footloose global executives and wealth creators.

The 50 percent top rate, one of the highest in the rich world, had been left as a poisoned political inheritance by the previous Labour government after the 2008 financial crisis, and its cutting to 45 percent was a key demand for right wing members of the ruling Conservative Party. Yet the tax cut for the rich is also a big political risk, with one opinion poll, by the ICM organization, showing that 67percent of voters wanted the 50 percent rate to stay.

Osborne insisted that the budget was still aimed at putting more pounds in the pockets of Britain's low and middle income workers, and that moves to close tax loopholes would see top earners and the buyers of expensive houses paying their fair share of tax.

Cuts kick in

Osborne, who has promised voters that "we are all in this together" as the country endures tough austerity measures, has taken a political gamble with this budget.

The plan to cut tax for the wealthy has unleashed a heated debate in the UK, but economists say the sums being saved and given away are relatively small; most agree that Osborne's budget will make little difference overall, arguing the figures from tax reductions pale in comparison to the government's ongoing spending cuts.

London South Bank University's Brian Ardy worries that the British public has not realized that - even though ministers have been talking about belt tightening for nearly two years - the full impact of public spending cuts has yet to be felt.

"I think the British public is beginning to realize how serious they will be," he said. "But they haven't fully realized it yet. Because it's bigger than anything that's been attempted before in the UK, and in any other country as well."

Some accuse the UK chancellor of trying to use the budget to repackage bad economic news after two years in power. Britain's national output is forecast to grow by just 0.8 percent this year while the economy is still struggling to come out of the steepest recession in decades. The government is running an eight percent deficit- forecast to fall to 7.6 percent next year.

Meanwhile, unemployment is set to peak at 8.7 percent this year, with youth unemployment at a 17-year high - now at 22.5 percent for those aged between 16 and 25.

Britain's mountainous public debt problems - set to peak at 76.3 percent by 2015 - are deep-rooted and date back to well before the financial crisis. The country's annual budget deficit - the nation's annual overdraft, in a sense - remains one of the highest in the developed world.

Appeasing the markets

The Conservative-Liberal Democrat coalition elected in May 2010 has staked everything on convincing international investors and bond markets that Britain is serious about fixing its shattered public finances.

Yet some economists argue that the austerity plans designed to bring down the deficit may have the opposite effect, by removing demand from the economy just when households and companies are themselves holding back. In effect, the government could be risking a dangerous spiral of fear.

Ardy sees signs of just such a debt spiral. "The economy came out of the recession, the new government was elected, and it started cutting the deficit, and since then the economy has not really been growing," he said.

But other financial analysts are convinced there are green shoots, arguing the UK is in better shape than its neighboring eurozone economies. And they credit the government's economic strategy, which they argue has calmed the markets overall.

Even a recent warning from two leading credit rating agencies, Fitch and Moody's, that the UK's top notch AAA credit rating may yet be downgraded has failed to make waves, with government supporters saying that the ratings agencies' concerns merely reinforce the government's message that this is no time to take risks with the public finances.

"Some people are seeing it as a small vote of confidence in what the government is doing," says IG Index's David Jones. "Because the government has been very fixed, on saying look, 'our target, is to get the deficit down, and really rein in our costs,' so what Fitch has said was okay, but if the budget deficit creeps up, then it will have an impact."

Save the savers

Even among natural government supporters, efforts to spur economic growth have sparked heated arguments. With many British households running up huge debts during the boom years, very low interest rates have been a key plank of the Bank of England's own efforts to shore up the economy.

Such low borrowing costs are good for families with credit card debts or hefty mortgages, but are grim news for the nation's savers, especially older people and pensioners who own their homes outright and were counting on savings to provide them with a reasonable standard of living.

The campaign group 'Save our Savers' represents people hit by years of base interest rates and rising inflation.

The group says an estimated 100 billion pounds ($158 billion) has been transferred from people who save, to those who have borrowed, over the last three years.

'Save the Savers' Simon Rose says Britain's savers are being penalized. "What we want to see is a return to an environment of more normal interest rates," he said. "The problem is that by having them almost at zero - at 0.5 percent which is the base rate - and by having all this quantative easing, pumping money they've conjured up out of thin air into the economy, it's gumming up the works. Of course there's no growth, because there's no incentive, for people to save."

Britain and the eurozone

Britain took a decision years ago to stand aloof from the European single currency, but even so the debt crisis in the eurozone continues to hang over Britain. British banks lent many billions of euros to neighboring European economies, and 40 percent of all British exports go to countries in the single currency area.

The UK is also a major trade partner of the United States, meaning that Osborne and Prime Minister David Cameron are anxiously watching efforts by the Obama administration in Washington to kick-start US growth. Ironically, Obama is using the help of the sort of fiscal stimulus spending that Britain has shunned.

British ministers would love to see the country export more to fast-growing emerging markets in Asia and elsewhere. But that is a long-term goal. As for the rising powers like China, pessimistic analysts say Britain does not have a solid enough manufacturing base to produce exports like machine tools that have proved so profitable for rivals like Germany.

British ministers have an answer to that. Give China and the other emerging powers a bit more time, and they will start wanting the sort of sophisticated services, from financial products to legal services or creative products like advertising, in which Britain enjoys an edge.

The most bullish British observers talk about London as the natural capital for the world's emerging markets, thanks to its banks, the English language and a time zone that allows it to trade with Asia and America at different ends of the working day.

Before Britain can get to that point, though, it has to survive the next few years without a major loss of international confidence. No wonder that the 2012 budget was, above all, about signalling that the British are sticking to their self-imposed diet of austerity.

Author: Nina-Maria Potts
Editor: Ben Knight